Opinion - Indonesia’s economy is starting to lose the confidence game

KUALA LUMPUR, 21 JULY 2026 —

Headline: Opinion - Indonesia’s economy is starting to lose the confidence game Lead: JAKARTA: Bank Indonesia (BI) has aggressively increased its benchmark interest rate recently to contain the fall of the rupiah, which has been under severe pressure since conflict broke out in the ... Body: JAKARTA: Bank Indonesia (BI) has aggressively increased its benchmark interest rate recently to contain the fall of the rupiah, which has been under severe pressure since conflict broke out in the Middle East. Within a single month, BI raised its rate by 100 basis points to 5.75 per cent. However, the currency has continued its downward trajectory against the United States dollar. When BI initiated this tightening cycle on May 20, the rupiah stood at 17,685 per dollar; it has since breached and hovered above the psychological threshold of 18,000 per dollar. This exceptionally sharp slide over the past two months points to something far more severe than typical market volatility: an extreme overshooting phenomenon. The currency’s collapse no longer reflects underlying purchasing power fundamentals, but rather a market disequilibrium driven by panic, massive capital flight and an acute shortage of dollar liquidity in the domestic spot market. Investor expectations play a pivotal role in dictating exchange rates. If market participants believe the rupiah will continue to weaken, they will preemptively sell the currency to buy dollars, creating a self-reinforcing downward spiral. Under such circumstances, even a large interest rate hike by the central bank cannot arrest the depreciation. As a tool for currency stabilisation, monetary tightening has distinct structural limits. While higher rates can theoretically attract capital, they also choke off domestic economic growth, which is precisely why BI cannot raise rates indefinitely. Looking back at the 1997–1998 Asian Financial Crisis sheds light on the delicate relationship between BI’s policy rates and the rupiah. During that crisis, the currency collapsed from approximately Rp 2,400 per US dollar in mid-1997 to nearly Rp 17,000 in January 1998. BI raised rates repeatedly; by early 1998, its benchmark rate exceeded 40 per cent, while overnight interbank rates skyrocketed to 100 per cent. Compared with pre-crisis levels, effective short-term interest rates surged by roughly 60 percentage points. This painful monetary tightening caused the economy to contract by 13.1 per cent in 1998, resulting in one of the deepest recessions in the nation's history. As Ben Bernanke, former US Federal Reserve chairman, put it, "Confidence is evanescent. It can go at any time for rational and irrational reasons. When it goes, it usually goes quickly, and it’s hard to get back." Monetary tightening alone did not save the rupiah. Stability was only achieved when the government implemented broad structural interventions, including bank recapitalization, restructuring, strategic closures and enhanced supervision. The introduction of a blanket guarantee for bank deposits successfully halted bank runs and restored trust in the financial system. Concurrently, strict fiscal discipline and structural reforms were enforced. Driven by this return of investor confidence, the rupiah appreciated from its low of Rp 16,000–17,000 per dollar in early 1998 to around Rp 8,000–9,000 by the end of the year, though it remained permanently altered compared with its pre-crisis baseline. The enduring lesson from the late 1990s is that aggressive interest rate hikes are insufficient to halt a major currency depreciation unless accompanied by bold, and often painful, structural reforms. Policy must actively foster credibility, because investor confidence ultimately plays the decisive role in stabilising a financial system. Investor confidence is a sophisticated architecture built on the rule of law and legal certainty, strengthened by policy consistency and maintained by institutional integrity. However, during his 22-month tenure, President Prabowo Subianto has issued a wide array of policies that have frequently been perceived as controversial, confusing and contradictory. The principles of meritocracy have been largely sidelined in bureaucratic and state-owned enterprise appointments, a trend that inspires little confidence among international investors. Furthermore, the flagship free nutritious meal programme, which already imposes a heavy fiscal burden, has increasingly faced institutional vulnerabilities. It has evolved into a highly controversial political lightning rod, widely criticised for being captured by patronage-driven political interests and rent-seekers. Compounding these concerns, the House of Representatives recently approved an amendment to the Financial Sector Development and Strengthening Law. This amendment effectively shields buyers of Danantara’s Red and White bonds from criminal prosecution, civil lawsuits and tax investigations. Under these new provisions the Financial Transaction Reports and Analysis Centre (PPATK) is statutorily barred from examining these transactions or flagging them as suspicious, while the purchase records themselves are legally prohibited from being introduced as evidence in a court of law. Left unchecked, Danantara risks becoming the largest legally sanctioned conduit for money laundering in Indonesia’s financial history. Because it is legally, morally and ethically questionable, this legislative shift threatens to severely erode international investor trust. Concurrently, a review by MSCI of the Indonesia Stock Exchange (IDX) in March exposed significant governance deficiencies, particularly regarding the opaque ownership structures of certain listed companies, low public floats and suspected coordinated trading practices. Consequently, MSCI delisted several Indonesian companies from its indices. Indonesia's struggle to comply with rigorous international standards serves as a harsh verdict on the country's economic institutions. While the market awaits MSCI's final review in November, capital flight has already intensified. Investors have fled the domestic market, causing the IDX Composite index to plunge 34.7 per cent in the first half of 2026, making it the worst-performing index in Asia. The stakes could not be higher. If MSCI downgrades Indonesia’s status from an emerging market to a frontier market, investor confidence could collapse entirely. Active funds tracking the MSCI Emerging Markets Index would be forced to fully divest their Indonesian holdings, while passive funds would drastically reduce their exposure. Capital market liquidity would dry up rapidly, making it exceedingly difficult for domestic companies to launch initial public offerings or raise capital. The ultimate objective of any government policy must be to secure the trust and confidence of business actors and investors, which forms the bedrock of long-term economic growth.… (AI-assisted rewrite, based on the original source)

Related: Bank Indonesia